In a recent series of articles, I challenged a number of other investing and personal finance bloggers to present us with their choice for the top 3 investing mistakes an investor can make. I did some additional thinking of the items on these lists and determined what I believe to be the top 5 ways an investor can lose money in the stocks. By not understanding and structuring your portfolio so that you avoid all 5 of these, you can limit your ability to be a successful investor.
Number 1 Way to Lose Money – Fees
The quickest and easiest way to lose money in your portfolio is to pay too much in fees. It doesn’t matter where these fees come from either – the fact is that fees take away your potential gains very quickly and limit the amount of money available to invest!
How do you avoid fees? First, do not trade in and out of stocks too often. Research the asset you want to hold in your account, buy it, and then monitor it to ensure it continues to meet your investment needs. There must be a darn good reason to sell it. Second, buy only low fee index funds and stay away from high fee mutual funds and mutual funds with any type of load. These will surely rip you off and destine you to below average returns.
Number 2 Way to Lose Money – Lack of Diversification
The second quickest way to lose money in the the stock market is to not have adequate diversification. This is a matter of risk management and without proper diversification, an investor ends up with too much risk with a low probability of offsetting returns. If the risk is unbalanced, then the loss of portfolio value can be very hard to come back from.
What does good diversification mean to you? It depends on your stage of life and your risk profile, however there are many arguments for a 60% / 40% split between equities and fixed income. Some research suggests that with this type of portfolio you can reach the same returns of the S&P 500 with much less risk.
Number 3 Way to Lose Money – Acting Like a Short Term Investor with Long Term Goals
If you are going to invest for the long-term, then act like a long-term investor. If you are a trader, then be a trader. Do not try to be both.
How do you be a long-term investor? Focus on strong and consistent earnings growth and the stock price will eventually do the work for you. In the short-term the stock may be very volatile – the short-term investor may sell and move on to a stock that is behaving more positively. The long-term investor will understand that stocks move up and down, and that if earnings stay strong over the long-term the stock price will rise.
Number 4 Way to Lose Money – Investing in Complex Investment Products
Do you think you can get rich by investing in a FOREX account or by buying equity-linked structured mortgage products? Maybe you can, but I am here to suggest that for the average investor these complex investment products will end up costing you more than you think. If I don’t understand it then I do not invest in it.
What should you invest in? I am not here to answer that question in completion for you – you need to look for assets that fit within your life and needs. However, I structure my portfolio to hold individual stocks, index funds (both equity and fixed income), and money market funds. Nothing more and nothing less. Those index funds can include emerging markets and real return bond funds (inflation protected) but they are always easy to understand and do not invest in a way that is risky nor unorthodox. If you can’t explain it to your mother, then it does not belong in your portfolio.
Number 5 Way to Lose Money – Not Educating Yourself on the Investment Process
The final way to lose money in the stock market is to assume ignorance and send your money to an investment advisor and letting them make all the decisions for you. Don’t get me wrong here – I am not suggesting investment advisors are bad. I am suggesting that you as an investor need to understand at least the fundamentals of investing so that you can be a gauge of rationality for your portfolio. The key is to make sure your investment advisor does not violate any of the above 4 ways to lose money.
How do you educate yourself on the investment process? Start reading as much as you possibly can. Investment books are one place to start. Blogs such as Canadian Capitalist, Dividends4Life, and Dividend Growth Investor are also other places to do research. Most importantly, keep yourself educated and the results will follow.